Earnings Call: Q1 2017

Apr 27, 2017

Summary

Q1 benefited from 8% like-for-like rental growth, SEK 833m of unrealized property gains and ~11% growth in property-management earnings. Guidance implied ~10% rental-revenue growth in 2017, with a larger project completion wave in 2018.

Welcome. After the good trend in our property market in recent years, many people are wondering and asking whether this trend will continue. I think the positive trend will continue as long as the favorable economic conditions persist. The fact that the government last week revised the GDP forecast for 2017 and 2018 upwards to 2.7% and 2.1% is perhaps the best indicator of continued strength in the property market going forward. Please turn page. If we look at our operations, the best indicators of demand and future earnings in the order mentioned are net lettings, increase in rent in renegotiations, and change in values. Ever since 2010, we have had a period of strong earnings, and if we compare the outcome for the last quarter with the outcome of corresponding quarters on these three items, we can see that the outcome this year is much higher than the average for the past seven years. The outcome this year is the second-best on all these three items. We are not just having a good start to the year. We also have an answer to the question. The favorable trend in the market is continuing. I am guessing that you also have still further confirmation of the favorable outcome for the quarter to report on. I have, Christian. Please turn to next page. The year has started well with growing rental income and earnings from property management, continued growth in value, and contained low-interest expenses. Rental income totaled SEK 546 million. The growth is due to completed projects and higher rent levels. Growth in identical portfolios totaled 8%. The surplus ratio was 69%. This is one percentage point better than in the previous year and in line with expectations and our target for the full year of 73%. Administrative expenses are slightly higher than last year, but we still anticipate around SEK 70 million for the full year. Interest expenses are more or less in line with the previous year. We are borrowing more money, but on the other hand, we have an increased share of capital market financing, and the fact that some of the old, more expensive interest rate swaps have expired has meant a lower average interest rate for the period. The average interest expense at the end of the quarter was 2.38%, compared with 2.64% at the end of 2016. Earnings in associated companies totaled minus SEK 11 million and relate to the capital contributions to Arenabolaget for the first quarter. As a result, earnings from property management increased by around 11% in comparison with the previous year. No new transactions took place during the first quarter. On the other hand, all takeover and vacating relating to previous transactions have taken place. After takeovers and changes in value, we now have a property value of over SEK 50 billion. The growth in value continued with unrealized value change of SEK 833 million, corresponding to a growth in value of just above 1.7%. Values in the project portfolio rose by SEK 338 million, producing a return on invested capital during the quarter of 48%. Value in management portfolio was driven principally by increases in rents, but also somewhat lower yield requirements. The average yield in the portfolio is now 4.48% compared with 4.53% at the year-end. The value of the derivatives portfolio continued to decrease SEK 89 million during the quarter. Deferred tax, lastly, is estimated at 22% on current earnings. Please turn to slide Key Ratios. The balance sheet has continued to strengthen in line with the favorable trend in earnings. Visible equity is now SEK 141 per share, and the long-term net asset value, the EPRA NAV, is SEK 165 per share. The dividend payment decided upon of SEK 662 million was expensed during the quarter but was paid in April. The equity/assets ratio consequently fell by one percentage point to 45%, and the loan-to-value ratio improved to 44%. The dividend payment means, all other things being equal, that the loan-to-value ratio will increase by just over one percentage point. In view of continued value-creating project investments and continued growth in value, this is felt to be a safe level. Please turn to slide Financing. The financing market, that is both the banking and the capital markets, continue to appear stable. No refinancing of bank loans were required during the first quarter. However, in line with our previous statements, we have increased the proportion of capital market financing in the portfolio, partly through new issues in our own MTN program and also through SFF. In view of the fact that the bond market does not have a STIBOR floor, bond financing today provides very competitive price labels. Interest in our bonds in general and in green bonds in particular, has been very strong. All the issues that we have made have been oversubscribed, and we have steadily reached even better levels. We are continuing to issue only green bonds, and the green financing has now grown to account for 23% of total outstanding loans. Including the commercial paper program, capital market financing now accounts for 40% of outstanding loans. Unutilized facilities at the end of the quarter totaled around SEK 2.4 billion. We still have scope to borrow more, both in our own MTN and through SFF, which provides us with the security of being able to both manage future project investments and to capitalize on new business opportunities. Some of the old, more expensive swaps matured at the end of March. These have been partly replaced by new 10-year fixed swaps at substantially lower levels. 57% of the loan portfolio was fixed through interest rate swaps at the end of the quarter. In April, we subscribed for a further SEK 400 million in 10-year swaps at levels around 1.1%-1.15%. Now back to Christian. Yes, I will talk about the rental market. As I said earlier, demand is very good, and this is explained mainly by Stockholm's growing, and the number of office workers is therefore also increasing, as you can see in this graph. Please turn page. Supply has been stable for many years, and the forecast is this continued stable supply, as you can see in this graph. Please turn page. High demand and stable supply have led to rising rents, and during the quarter, we saw many examples of new lettings at high levels. For example, all lettings in our project properties took place at levels of at least SEK 3,000 per square meters during the quarter, and that's a level we never have been on earlier. Last year, we said that net lettings were less important as we already had a high secured project volume. We are now starting on the job for topping up with new projects that can replace all the projects being completed in 2018. SEK 21 million in net letting during the first quarter is a good start on that journey. The increase in renegotiation rents came out of 20%, adjusted for some contracts in project properties with waiver of security of tenure, the level of increase was 24%, broadly in line with the previous annual average of 23%. Please turn page to transaction. We did not make any transactions during the quarter, and we have externally valued 29% of the portfolio. The strong property market in Stockholm has produced growth in value of SEK 833 million. Please turn page. The change in values of SEK 833 million are due to the relatively equal contributions from the project portfolio, rise in rents, and fall in yields requirement, as you can see in this graph. Please turn page to project portfolio. Let's turn to our project portfolio, which is continuing to create value. Our ongoing project volume is now at a record high level and is temporarily above 200,000 square meters. When SCB in May moves in in its first stage, the volume will decrease by around 50,000 square meters. Vacancy rates decreased during the quarter in Pelaren and Varv 6. Overall, however, the occupancy rate fell from 80% to 79% as we started a new project in Hammarby Sjöstad during the quarter. This new project is Trikåfabriken 9, as you see on the next page, and it has an attractive industrial architecture, and it's being supplemented by an exciting extension. When it is completed, it will have around 16,000 square meters of office space. Around 50% was pre-let to the Swedish Environmental Protection Agency during the quarter. We now have 44,000 square meters of unlet spaces in our major projects. We have 1-3 years to find customers before the buildings are completed. We have modern buildings and attractive locations, and this is what our customers are looking for. I therefore strongly believe that all the 44,000 square meters will, in principle, be let by time of completion and that we also will have further increase in our revenue growth. Please turn page to outlook. As a result of completed projects and rising rents, we already now know that revenue increase of around 10% during the year. 2018 is in fact looked like being even better as the project volume being completed is more than 100,000 square meters. Please turn page. We do not just see increase in revenue in 2017. We also see continued stable cost. Together, this is leading to a rise in earnings from property management. We also see the strong demand will continue to contribute to good growth in values, mainly through projects and rising rents. Please turn page. We also see the Stockholm region is growing, and it is going well for companies today. The forecast is that Stockholm will continue to grow, and it will continue to go well for companies. We therefore believe that there will continue to be a strong demand. We are ideally placed to benefit from this demand, as we have both the products and the organization that can create the best solution for our customers' needs. Thank you. That was all from Åsa and me. Our first question comes from Erik Granström from Carnegie. Please go ahead. Your line is now open. Thank you very much. My first question is regarding the value changes. You mentioned that you externally valued almost 30% of the portfolio, but could you tell us a little bit about what part of the portfolio you looked at externally? Was this a mix of all the properties in the different areas of Stockholm, or was it tilted to a certain area in Stockholm in particular? Yes. Hello, Erik. It is last quarter we evaluated 75% external. This quarter it is mainly those properties we didn't valued last quarter, and we also took other properties where we have seen changes in contract. I would say it's a mix, because on a yearly basis, the whole portfolio will be externally evaluated, and from each quarter, there is a mix of properties in all the areas. Okay. Thank you. Could you also tell me a little bit about what your expectations are for yield requirements? Yield requirements were lower now in this quarter than by 5 basis points. I assume partly related to the fact that you're doing this 29% this quarter rather than the last quarter. What are your expectations for yield requirements going forward for this year? Do you think that we could see the same kind of yield pressure that we saw in 2016 or more or less? I don't think we will see the same pressure on yield this year. I still believe that we will see yield compression and mainly through that reason that the valuators are lagging to the market. We are still believing that the market is on lower levels that the valuators believe today. I'm looking forward to see the result from some properties who are out on the market today. It's not in our portfolio, but we know that there is properties out on our market, which will give us evidence where the yields are in the future. I believe that will have an impact on, that we will see that yields probably will be even lower during the year, but not a massive change. Okay, thank you. My second question is that you did have a rather solid operating surplus margin in Q1. I would assume that this gives you more confidence, or confidence, actually, I should say, in reaching your 73% target for 2017. Is that a correct assumption? That is correct. The 69% for the first quarter is in line with our expectations. All right, very good. The central overhead costs were a little bit higher than we saw in Q4 and a little bit higher than I expected. Were there any sort of extraordinary items that you accounted for in Q1, or is SEK 19 million a level that we should expect going forward as well? No, there were a little more extra cost in Q1, so we still believe that the SEK 70 million or around SEK 70 million for the full year will be as expected. All right, very good. Finally, I guess I need to ask you something about the tax proposals. You touched upon that as well. My question would then be, have you noticed anything in the transactions market at all during the first quarter of this year? Because obviously the proposal were rather well-known in your line of work throughout this year. Have you seen any sort of prolongance of discussions or any discussions at all in regarding the transactions market with respect to these proposals? No. I wouldn't say that we have seen any impact on it so far. All right. Thank you very much. Those were all the questions I have. Thank you. Ladies and gentlemen, as a reminder, if you do wish to ask a question, please press 01 on your telephone keypad now. We have some questions from the webcast as well. What is construction cost inflation running at an annual rate so far this year? We have been waiting for cost inflation during many years, but we haven't seen it so far. But we see that the problem is getting bigger in our market, and it's harder to buy developers who can help us on the levels we have our budgets on. But since we're working more and more with foreign developers also, we also could have kept the level on our budgets. But it is a little bit bigger and bigger cost problem in the sector, especially on the installation side. Assuming new tax proposals come through intact, will you alter your business model towards more of the holder of real estate and slow down pace of development and recycling of capital? No, I can't see that the tax proposal will have that impact today, and we don't know what it will end up with. But today, I can't see that. I don't know what you say, Åsa, but I can't see that that will have any impact on our business model as I see today. No. I agree with you. We are already targeting to keep more of the properties that we develop than we have historically. Last year, we sold two large properties. This year, we don't have a target for disposals, and our target is to keep more of the fully developed properties. So even if the new tax system is implemented, I think it will have less impact on the future of Fabege than we have seen previously. The last question from the webcast. What is the total incentive as a percentage of normal rent you have given in order to achieve 20% positive revision of renewals? Normally, no renegotiation is like the other. But as the market is very strong today, there is less incentives today than normal. I can't give an exact percentage, but it's less than normal, I would say today. In renegotiated contracts, I think incentives is very close to zero. Yeah Because the market is so strong, and there are very few alternatives for companies that are looking for new premises. It's different maybe when you make new lettings, and a company have also the cost for moving, which you, in some cases, can compensate them for. Yes. Ladies and gentlemen, if you do wish to ask a question, please press 01 on your telephone keypad. We do have one question from Niclas Höglund from Nordea. Please go ahead. Your line is now open. Yes, good morning. I am sorry I was a little bit late in the call. I have a follow-up on projects. I heard your comment that the general yield decline is more likely not to continue as strong as we have seen before, but you have a very strong portfolio of projects. I would like you maybe to comment on the, you can say, the time contribution on your revaluation of projects, i.e. more as a percentage of completion and maybe how you look at the opportunity to continue to start new projects. We have seen at Tuborg Torg this quarter, and what is your outlook for the full year? Thank you. Hello, Niklas. Yes, we are every day looking on starting new development projects, but we do not start any project on speculation, so we want to have a contract before we start them. We have a lot of building rights in the portfolio, so the possibilities are there, and the building rights are more or less booked at cost, so they have not been revaluated. As you were saying, Niklas, the revaluation potential in the project portfolio and in the building rights portfolio is very good. We have to start projects, and we have to find tenants in order to realize these values. We still see a big potential also in the existing project portfolio, because normally you have more revaluation, the more lettings you can make and also the closer you come to finalizing the projects. Normally you have a bigger part of the right up towards the end of the project. So there will be revaluation potential in the existing project portfolio, but also in the building rights portfolio. Yeah. Could you maybe split out, give us a feeling of the sort of the percentage of completion part of your project revaluation right now? Or is it difficult to take that out from the equation? Normally, we feed in the revaluations in the projects gradually over the time of the project, but a little bit more towards the end. So that's about how we describe it. Yeah. Thank you much. Since more than 50% of the portfolio will be finalized next year, I think that we will see we have a big value uplift potential for the next year, as it looks today. Looking forward for the SEB bank building to be finalized then. Thank you. There are no further questions at this time. Please go ahead, speakers. If there is no more questions, I will thank all the listeners that you have been listening, and also thank you for all questions. Thank you from Åsa and Christian, Fabege. Thank you.